As we near the end of July we're struck again by how news in the insurance and reinsurance industry never seems to slow down. This month has been no exception.

A considerable discussion about the so-called "coverage gap" has arisen and the inadequate coverage isn't where you think it might be--it's much closer to home.

There was much news from Lloyd's. Management indicated that it fully expects the Lloyd's market to shrink over the next two years as underwriters pull back from insuring under-priced risks. However Axis has swooped in and purchased Novae a syndicate which only has Lloyd's business.

As could be expected since premiums continue to decline and underwriters pull back from writing certain risks brokers are faced with decreasing commissions. This month we see how one broker has responded and how another broker in turn may try to capitalize on broker fee increases.

Meanwhile our Monte Carlo schedule is rounding out nicely. We will be not only talking about our two new Data Vera products but describing several additional new initiatives such as our new operation in India and our newly enhanced Pivot Point applications.

Our regular Roger Crombie column is here too. This month Roger is wondering about the role of the current governor of the Bank of England. Roger has a few words to say about the new UK currency too.

As usual we will not be releasing an August issue of CATEX Reports. The next time you will hear from us will be just before the Monte Carlo Rendezvous so enjoy the summer until then.

As always if you have any questions or comments about CATEX Reports, or want more information about CATEX, or our products, please feel free to contact me.

Thank you very much.

Sincerely,

Stephanie A. Fucetola

Senior Vice President/CATEX

Studies reveal coverage gaps close to home

A recurring theme in insurance and reinsurance focuses on the so called "coverage gap" or more broadly "under insureds." When we first noticed this concern, several years ago, the thinking was that areas of the world that were breaking into the ranks of more developed nations would now require types and amounts of coverage we see in more mature markets.

A number of studies and plans, including the Lloyd's Vision 2025 document, are largely premised on this expected new business, which would hopefully lead to new premium. Of course that thinking makes sense. As growing economies attain levels of affluence the thinking is that insurance needs similar to more mature economies will likely emerge.

For a while it was hard to read an industry trade journal without seeing a story about carrier or broker expansion in China, India, Southeast Asia or Latin America. After a while stories began to be seen about expansion to the African market too. New clients would mean more business --earned it was thought by selling them insurance products similar to what their more developed peers were already buying.

That all makes sense but there is another axis on this graph of prospective premium growth too. It's an axis that everyone paid lip service to and usually was noted as "unforeseen risk." Where there is risk, foreseen or unforeseen, there is an opportunity for coverage and where there is coverage there is premium.

The industry is aware of unexpected and unforeseen losses from its own history. The
asbestos claim crisis of the
1990s and the discovery of the dramatic level of
premium inadequacy in Florida after
Hurricane Andrew in 1992 jolted the industry to fill those coverage gaps. Sometimes the gaps were filled by eliminating coverage for certain LOBs but more often than not increases in premiums were the result.

There is a potential big jolt that may be emerging right now. It's arising not out of the emerging economies but in fact, right under our noses in the more mature markets. We've been reading about cyber risk for several years but it took a
report published by Lloyd's earlier this month to outline its potential dimensions.

Let's put this in context first. No less an authority than
Stephen Catlin has
observed that "the
potential systemic risk arising from a collapse of the Internet is the
greatest exposure I've ever considered during my insurance career. When insurers have modeled true catastrophic losses in the past, they have modeled elemental risks that, by their very nature, are relatively localized. However, inter-connectivity of data systems worldwide means that a severe cyber breach will affect companies from the US to China--and everyone in between --at a whole new level."

Catlin's observation came to mind when we read about the
Internet outage that
affected the entire country of
Somalia for three weeks. The underseas cable that provided the country's connection was severed and for three weeks hospitals, businesses, banks, government, schools and the general public were essentially treading water or worse. Certainly, as bad as the effects of the outage were, the affected infrastructure in Somalia pales in comparison to a more industrialized country.

The Lloyd's study showed that under one scenario a major outage at several Internet service providers could result in as much as
$121 billion in economic losses or about 2.5 times the economic loss from Superstorm Sandy. How much of this $121 billion would be covered by insurance? The study found that
only about $8.1 billion of this loss would be insured.

The study looked at several loss event scenarios but the conclusion was that in one scenario between 14 and 17 percent of economic losses would be insured while in the other scenario, the one described above,
only 7% of economic losses would be insured. The study, per Catlin's observation on inter-connectivity, focused on global effects of a cyber incident.

We saw the initial story when Lloyd's put the study results on-line and immediately did the math about the insured loss percentages. We thought we were wrong with our number but as the day went on other media outlets picked up the story and actually began to feature the uninsured percentage as the story's lead. Per the study at least that's the right number.

The number speaks for itself but notions of "under-insurance" and "coverage gaps" quickly come to mind. It was a revelation to have numbers attached to such scenario. One cyber underwriter we know has told us that what keeps him up at night is contingent business interruption (CBI). What would happen if a provider such as PayPal or Square encounters a disruption cutting the service for a week? Think of the billions of dollars of losses that would ripple through the cyber marker from smaller customers.

Finally, the effects of the
Grenfell Tower fire continue to ripple through the industry. Following the fire many dozens of similar high rises in the UK
have been found to have similar exterior cladding to the type being blamed for accelerating the Grenfell fire. The cladding issue may not be limited to the UK alone as speculation has now
centered on
certain US structures too.

At a
Verisk Risk Symposium in London
Ascot's John Pilkingtonnoted that one of the issues emerging from the Grenfell fire is under-insurance --
entities and businesses are not currently buying insurance to value.

Estimates for the cost to insurers from the Grenfell fire range from
200 million GBP to 1 billion GBP and Pilkington explained how carriers can be affected. In the past "if that fire had happened they would have gone to two or three parties because the limits may have been sufficient to cover the liability element of the loss. But the loss from Grenfell, the limits aren't big enough so they will go deeper and deeper to tap limits."

Pilkington warned that from a reinsurer's perspective this could mean that even though a carrier does not insure or reinsure anyone who provides the liability limit to Grenfell's owners they "may reinsure somebody who provides the architect and engineers insurance policy."

The liability limit at the time of purchase probably seemed reasonable. However, post- loss, with a potentially huge liability exposure developing,
every policy connected to anyone who in turn is connected to Grenfell is going to be examined. This is not unlike the route American plaintiff attorneys followed during the asbestos claim crisis of a generation ago.

So just the news from this month alone has revealed under-insurance gaps in cyber risk and single casualty events. Industry analysts and underwriters may not necessarily be surprised at the potential amounts of under-insurance in these mature markets. However in a time of declining premium, combined with the continuing influx of alternative capital, we wonder when these risks closer to home will become attractive to insure. We know that the day will come.

Lloyd's warns market will shrink but Axis buys in

There were several Lloyd's related stories this month. We observed in our last issue that
Jon Hancock the Lloyd's Performance Management director had used
Darwinian terms to note that certain syndicates might not survive what he thinks will be a constricting market at Lloyd's. In a letter to the market earlier this month
Lloyd's CEO Inga Bealeconfirmed that Lloyd's expects the market to shrink.

Beale noted that Lloyd's oversight activity "is focusing on all elements of combined ratio rather than almost exclusively on loss ratios. At individual class level and aggregate level we will continue to focus on loss ratio and downside risk management. Given current conditions, improved performance
means the market should shrink in 2017 and 2018 as underwriters maintain strong discipline."

We've noted in the past that Lloyd's is mindful of the effect that underwriting discipline is having on the market and that premiums are decreasing. To this effect Lloyd's is planning on

Everyone it seems is buckling down for a continued cold spell. The
news from the
mid-year renewals in Latin America at least seemed to confirm this trend. According to the Insurance Insider "Brokers are understood to have been pushing for rate reductions of up to 25% in some situations." The Insider concluded by noting that "average reductions for renewing treaty business were likely to be in the mid-single-digit range."

During this month
Axis Capitalannounced that it had reached an agreement to acquire Lloyd's syndicate
Novae for
$604 million. Novae had been in the news of late and had recently
announced "
its exit from some business segments, shutting down its casualty division to rebalance its portfolio and focus on more profitable classes." Novae in particular was hard hit by the Ogden rate increase and was forced to take a 55 million GBP hit to its reserves.

But Novae had in fact winnowed its underwriting focus down to core classes that included US property binders, cyber, political risk and marine liability. To an outsider the moves Novae had been making of late seemed to all be aimed at jettisoning unprofitable lines and establishing a focus only on profitable business.

As a smaller syndicate, with no operations outside of Lloyd's, Novae was working with a far smaller margin of error than larger syndicates with extensive non-Lloyd's operations. Novae it seemed had indeed received the memo about the upcoming "winter" expected at Lloyd's and seemed to be diligently preparing for it.

Enter
Axis CEO Albert Benchimol. You may recall that two years ago Benchimol had been on the brink of acquiring
PartnerRe only to have the company
snatched away from him by a bid from the
Agnelli family controlled
Exor investment vehicle. After the Novae acquisition the combined Axis and Novae Lloyd's operation will move Axis
into the top 10 by capacity list at One Lime Street.

The Novae Board recommended that the shareholders accept the Axis offer but there had been
talk that
another suitor could emerge to offer a bid higher than Axis. One could well imagine Benchimol wondering if Axis was going to end up in another bidding war as they did with Partner.

In the end it seemed that most potential acquirers for Novae agreed with
Validus' Ed Noonan. Validus already owns
Talbot, a Lloyd's syndicate and speaking of Validus' overall Lloyd's business Noonan
said"This isn't a great time to be growing it so we've been letting it shrink," he continued. "We're trying to preserve margin rather than market share."

The title of the Insurance Insider View on July 6th was "Brave Benchimol". Benchimol is a serious man and a very successful one at that. However the Insider observed that "Benchimol will have to be honest with Axis shareholders about what London --and Lloyd's even more so --looks like at the moment. Rates have been filed down to the point where even without significant CAT loss activity the market is in a loss position on an accident-year basis. Underwriting profits are entirely reliant on reserve releases."

The numbers for the Novae acquisition seem to work for Axis. Without delving too deeply into details commentators seem to believe that deal synergies and annualized savings will end up costing Axis one or two quarters of book value growth to obtain the additional $940 million of premium Novae will generate in 2017. And, as noted, Axis will move into the Top 10 of Lloyd's capacity providers.

Clearly Benchimol is taking a long view and the opportunity to acquire a so called "pure play" at Lloyd's was too good to resist. The duration of Benchimol's view may not even be so "long" --as we all know things can change very quickly. It's possible that in only a year or two we will look back at this deal and think Axis managed to obtain a good deal by paying a price 20% above Novae's stock price.

From Novae's perspective, even after its internal reconfiguration, it still expected to lose money in 2017. Despite complaints from some shareholders the Axis offer provided an immediate and certain payoff for all the sacrifice Novae had made ridding itself of unprofitable business and shoring up its reserves. It's understandable why Novae management recommended that the stockholders approve the deal.

It seems that even in times of famine M&A moves can and are being made. Certainly Benchimol is indeed "brave" but if we had to bet on it it seems a safe bet.

JLT SMB fees introduced

Interwoven within the discussion about the shrinking Lloyd's market is the theme of expenses --acquisition expenses in particular. In the "Brave Benchimol" piece cited above Insurance Insider
observed that Axis's acquisition of another Lloyd's platform comes while "
brokers have been relentlessly driving acquisition costs higher in a phenomenon that has been strongly augmented by an increased reliance on MGA distribution."

We've become sort of numb to stories about
new broker fees or
new commissions. We understand that brokers see their revenue dip as premiums decrease and overall written business declines. The challenge they have is to provide additional services and then levy charges for those new services. It's a tough market everywhere and brokers, unlike carriers, don't have claim reserves they can release as time passes.

When we read this article titled "
JLT signals intention to roll out SMB in London" we didn't think too much of it. The story describes how
JLT has told markets that it intends to levy
subscription market brokerage (SMB) on classes of business where placements are syndicated.

Syndicated placements are no easy matter. Having to deal with multiple markets each with different risk appetites and different pricing needs is really where the broker earns his or her value. Few cedents would venture into this arena without a broker leading the way --there are too many pitfalls and too many variables to manage.

Keep in mind that a market could well point out that
it already pays a broker a commission on a syndication and requests, such as the one made by JLT, really amount to additional commission. Carrier sources say that the SMB's being asked for by JLT
could amount to an additional 3% commission in some areas.

We've seen this before with other brokers so the story headline didn't really strike us. Then we read further. Apparently "underwriters are in a position to strike SMB from slips when it is presented to them,
potentially leaving different insurers paying different levels of brokerage on the same risk."

The article stated that "Underwriting sources have said privately that they
feel forced to make a calculation on whether or not they are likely to lose the business if they choose to take the SMB off the slip."

That's quite a statement. For its part JLT has issued a brochure called
"Market Brokerage" in which it
states that the use of SMB should not play a part in determining which markets business is placed with. The statement read "Market Brokerage
must not influence or determine the placement of business nor should it affect JLT's obligation to act in the best interests of its clients."

The brochure also notes the host of administrative functions JLT is called on to perform in the case of subscriptions as reasons for an SMB that is "reasonable, justified and proportionate."

JLT's reasoning may well be sound but we suspect that at least part of the tension here is that until now markets
could decline to pay the SMB and JLT would be compensated by receiving only its normal brokerage. Apparently,
JLT is going to try to ensure that all markets on a subscription pay the SMB and no longer selectively apply it.

It's a tough argument though as JLT is also
publicly stating that even if an insurer declines to pay the extra SMB it won't be treated any differently than one who does. We'll see what happens but
Willis Towers Watson, Marsh and Aon have recently encountered this issue too.

In a letter to London market executives
Lockton stressed its approach to remuneration was cooperative. According to reports the letter said "We want you to treat us fairly in the market, but recognize that we are not receiving,
nor asking for the same levels of compensation through facilities as some of our competitors."

Major brokers have been able to derive additional revenue from the London market through facilities fees and SMB's. Independent brokers, with smaller books of business and much less risk data for underwriting analysis, have not been able to penetrate the facility market and per Lockton's efforts at least seem to be making virtue out of a necessity.

As for the SMB's? Certainly while Lockton may be quite capable of structuring a syndicated placement their own ability to charge an SMB (and there is no indication that they want to) would seem limited. We noted that if carriers feel they are in a strong enough commercial position with a broker trying to levy an SMB they can strike it from the slip. One underwriter
said "
It's just an arm wrestle between you and the brokers. Sometimes you win and you can take it off, mostly you can't."

As we said...virtue out of necessity. It's unlikely that the independent brokers could win such an arm wrestling match.

Alternative capital comes down the "food chain"

A few years back the possibility that
alternative capital would soon make its way down the famous
Ajit Jain"food chain" to
underwrite commercial insurance market risks was a subject of discussion at insurance and reinsurance conferences.

That day seems to have arrived
according to Moody's. Alternative sources of capital, largely from ILS funds, are increasing its market share in commercial insurance,
particularly in the CAT exposed property sector that have seen rate declines of a magnitude that traditional carriers are beginning to reduce their risk appetites.

According to Moody's in addition to many reinsurance lines, who have long been pressured by alternative capital, the
primary insurance market is now being pressured too. In fact, partly because of this additional capacity Moody's anticipates an
overall 1.5% decrease in pricing in 2017 across much of the commercial P&C sector.

ILS and other alternative capital has apparently taken a page from the playbook of certain traditional markets and moved down the chain to get closer to the source of risk. Avoidance of ceding commissions and brokerage fees can make this attractive to them too it seems.

AIG turns from pursued to pursuer

It would be inappropriate we think to not at least mention some of the developments occurring at
AIG since our last issue.
Brian Duperreault has firmly taken the reins at the huge carrier and has
appointedPeter Zaffino as AIG COO. Zaffino of course worked with Duperreault at
Marsh as management turned around the fortunes of the big broker starting in 2008.

Duperreault has also made it clear that he
believes that AIG can cease selling off assets and is in fact in a position to grow both organically and by acquisition. There will be no more calls it seems to break up AIG,

Leslie Scism of the Wall Street Journal has written an interesting
article about Duperreault and his background that is worth reading.

Why has BOE Governor's role been politicized?

Roger Crombie

As Chairman of the Federal Reserve, Alan Greenspan was first revered, and then vilified. When the boom was on, Greenspan was a steady pair of hands. When he hit on reducing interest rates, he weakened the Fed's clout by beginning the removal of its chief tactical weapon.

In the US, the Chairman of the Fed is expected to be a player and, to a lesser extent, a personality. The current incumbent, Janet Yellen, is more of the former than the latter, in part because Greenspan and his mini-me successor, Ben Bernanke, reduced the Fed's influence over the economy so sharply.

On the other side of the pond, the present Governor of the Bank of England, Mark Carney, is what the British call "all mouth and no trousers." He has comprehensively misunderstood his function and made a dog's breakfast of almost everything he has taken on.

Carney sees himself primarily as a political figure. Publicly taking sides is his default setting; taking the wrong side, his unenviable record.

Mark Carney is the 120th Governor of the Bank of England, a role established in 1694. There have been a few wrong'uns in the intervening 300-plus years, but this man is in a class of his own.

The Governor was, by tradition, a discreet business or judicial figure, who rarely if ever made public pronouncements. Independent beyond reproach, the Governor acted in the best interests of the nation's economy and left the politics to the politicians. He (always he) did not feel the need to explain what he was doing. He just quietly did it. His deed was his word.

We live in the age of celebrity. People magazine might have articles about Caitlyn Jenner, the Pope, a mass murderer and a fashion model, one after the other. They're all celebrities.

Carney, brought over from Canada for £874,000 ($1.1 million) a year, did little of note until Brexit came along. Most of the time, doing little of note is the Governor's job description. A tweak here or there when things go wrong, but otherwise, no rocking the boat.

As the Europe debate heated up, Carney very publicly joined the Remain group. A Governor taking sides, or worse, a Governor letting you know that he had a side! The idea is so laughable as to deserve a second exclamation point, were such a thing permissible.

The carney barker used the weight of his position to supposedly add gravitas to his wild-eyed threats. The British would assign themselves to a future of permanent penury, the Governor assured us, were they to vote to break with Europe.

From there, it's been all downhill. New banknotes and coins are being introduced. It is a truth universally acknowledged (by me) that changing banknotes weakens the currency they represent, but security reasons made the change imperative. Thirty percent of all Pound coins were fakes, and a high-tech replacement was necessary.

The new Pound coin is OK. Every dog has his day; chalk one up for Carney.

The new five-Pound banknotes, by contrast, are awful. Polymer currency was necessary, the Bank decided. Despite a dozen countries already having used plasticated currency for ages without problems, the Bank took years to decide on the new designs, and then got them horribly wrong. The new notes are slimy little numbers, containing punctuation errors.

Animal activists and Muslims were upset to discover that the fiver contains tallow, i.e. animal fat, because it's hard to do greasy without it. Carney ignored their complaints.

The tenner is next. Its design caused feminists everywhere to lose control, which in turn caused everyone else to lose control.

In short: militant feminists said that we must have a woman on one of the new banknotes. It escaped their attention that every single banknote since the mid-1950s has had the Queen's face on the front. Doesn't count, the feminists said. Oh please, said everyone else, except a few nutters who brought the rage of the anonymous Internet down on the feminists' shoulders.

The new tenner comes out in October, featuring a sexed-up Jane Austen (reportedly a plain woman) on the rear. It too will be slimy.

Now comes news that the Bank of England has urged insurers to obey the law, and then adhere to an indefinable moral code beyond the law. Sam Woods, the head of the Bank's Prudential Regulation Authority (PRA), said recently that some insurers are engaged in "pure regulatory arbitrage" by adopting practices that "might meet the letter of the regulation, but are designed to circumvent the spirit".

Woods told insurers that they "should be prepared to defend their compliance, not only with the letter of the regulation, but also with our principles."

I'm suffering from outrage fatigue. You do the smart-ass commentary for once.

Carney is due to leave office in 2019. Donald Trump might be looking for work by then. He'd be an improvement.

**************************

Roger Crombie
is an American Society of Business Publication Editors national award winner. An English chartered accountant who lives in Eastbourne, on England's South Coast, he writes and broadcasts news and opinion in the US, UK, Bermuda and the Caribbean, in print and online. His main beat is insurance and financial services, with 30-year sidelines in music and humour. All views expressed in Roger's columns are exclusively his own. Contact Roger at roger.crombie@catex.com.

Copyright CATEX Reports

July 24, 2017

Quick Bytes

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